Strange Bedfellows: A Fairly Simple Solution To The Default Crisis

A very curious thing is happening in the continuing saga of the US default crisis: progressives are starting to come together behind a plan floated by none other than Rep. Ron Paul. Yes. That Ron Paul.

Stranger things have happened. After all, many progressives find themselves on the same side as Paul when it comes to the wars in Iraq and Afghanistan, and even on drug policy. What’s that they say about even a broken clock being right twice a day? It seems Ron Paul may just be the proverbial broken clock.

Representative Ron Paul has hit upon a remarkably creative way to deal with the impasse over the debt ceiling: have the Federal Reserve Board destroy the $1.6 trillion in government bonds it now holds. While at first blush this idea may seem crazy, on more careful thought it is actually a very reasonable way to deal with the crisis. Furthermore, it provides a way to have lasting savings to the budget.

The basic story is that the Fed has bought roughly $1.6 trillion in government bonds through its various quantitative easing programs over the last two and a half years. This money is part of the $14.3 trillion debt that is subject to the debt ceiling. However, the Fed is an agency of the government. Its assets are in fact assets of the government… In this sense, the bonds held by the Fed are literally money that the government owes to itself.

Unlike the debt held by Social Security, the debt held by the Fed is not tied to any specific obligations. The bonds held by the Fed are assets of the Fed. It has no obligations that it must use these assets to meet. There is no one who loses their retirement income if the Fed doesn’t have its bonds. In fact, there is no direct loss of income to anyone associated with the Fed’s destruction of its bonds. This means that if Congress told the Fed to burn the bonds, it would in effect just be destroying a liability that the government had to itself, but it would still reduce the debt subject to the debt ceiling by $1.6 trillion. This would buy the country considerable breathing room before the debt ceiling had to be raised again. President Obama and the Republican congressional leadership could have close to two years to talk about potential spending cuts or tax increases. Maybe they could even talk a little about jobs.

There are a few downsides to this scheme: it would reduce the funds available to the Fed to administer its own programs (such as the fledgling CFPB); it could conceivably lead to less bank lending; and of course, it looks bad: as if we don’t live up to our obligations. However, since the “obligations” in this case are completely internal, the way it looks is really an issue of educating the public. Indeed, the greatest obstacle to this plan is explaining it to the non-economist.

Given that the alternatives are either: a disastrous default on the national debt which could plunge us into not just a double-dip recession, but into a full-blown depression; or disastrous budget cuts which would pretty much have the same effect, the Paul plan is looking like a lifeline. Of course, one may question Paul’s motivation; he has made no secret of his desire to destroy the Federal Reserve. And it’s possible that like-minded folks could use this act to try to undermine the legitimacy of the Fed. Still, regardless of the source, this proposal deserves serious consideration, and the rumblings in D.C. are that progressives are giving it just that.

Sandi Behrns is a noted policy nerd, new media & web developer, and consultant to progressive organizations and campaigns. She is a senior contributor to Liberaland, and the Executive Editor of Progressive Congress News.